3 Ways Retirees Can Maximize Their Upcoming 8.7% Social Security Increase

For retirees claiming Social Security benefits, good news is coming in 2023. Benefits will increase by 8.7%, thanks to the recently announced cost-of-living adjustment. It’s the most significant increase in benefits in more than 40 years.

But the flip side is that you could end up paying more taxes on your Social Security benefits if you are not careful.

The Internal Revenue Service (IRS) requires retirees to count a portion of their benefits as taxable income if their combined income is above a certain threshold. Combined income consists of adjustable gross income such as earned wages, non-taxable interest such as income from municipal bonds, and half of your Social Security benefits.

If your combined income is above $25,000 (for individuals) or $32,000 (for married couples), you must pay taxes on as much as half of the income above these thresholds. If your combined income is above $34,000 for individuals or $44,000 for couples, you will pay taxes on up to 85% of any income above these thresholds. The tax rates are not 50% or 85% for this income, but this is the maximum amount of income above these thresholds that will be subject to taxation at your tax rate.

With such a sizable bump in Social Security benefits next year, your combined income may very well accidentally surpass the tax-triggered thresholds. Here are three ways to reduce your combined income and therefore maximize that 8.7% Social Security increase.

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1. Tax-loss harvesting

This should be a particularly relevant strategy right now, considering that the market has gotten crushed this year. The S&P 500 is down nearly 22% this year, which means that some stocks in your portfolio could be trading lower than when you bought them.

If this is the case, maybe hang onto these stocks until next year. If they are still trading at a loss toward the end of 2023, you can sell them to lower your total capital gains, which may lower your overall combined income.

If your capital losses outweigh your capital gains, you can actually write off up to $3,000 of your ordinary income, which could be significant in getting below those tax-triggering thresholds. If your capital losses surpass $3,000, then you can write off $3,000 one year and carry any losses over $3,000 to future years.

2. Donating IRA required minimum distributions

Once you turn 72, the IRS requires people to begin taking required minimum distributions (RMDs) each year from certain retirement accounts, including traditional individual retirement accounts (IRAs). RMDs typically count as taxable income.

If an RMD will put you over a certain tax threshold, you may have the option of doing a qualified charitable distribution to donate the amount that puts you over. However, this is only an option for retirees who are at least 70 1/2 or older.

But if you meet this requirement, you can donate as much as $100,000 from your IRA, and these donations will typically allow you to avoid counting that portion of your RMD as taxable income.

3. Buy a QLAC

A qualified longevity annuity contract (QLAC) is a type of deferred income annuity that is another way to lower your RMDs and keep your combined income lower. QLACs are designed to help retirees ensure they have enough savings to last them deep into their old age.

Using a QLAC, a retiree can take a lump sum of money from their pre-tax IRA and pay it upfront so it will come back to them through monthly distributions later on in their life. A QLAC can’t begin for at least a year after the lump-sum payment is made, but can be deferred all the way until the age of 85.

For a QLAC, specifically, retirees can take the smaller amount of either 25% of their IRA balance at the end of the previous year or up to $145,000 and make it as a lump-sum payment. So, if you have an IRA balance of $580,000 or more, you can put up to $145,000 into a QLAC. Otherwise it’s 25% of your IRA balance. However, next year this amount will likely be higher because QLAC limits are adjusted for inflation.

A retiree’s RMD amounts are calculated based on their total IRA amounts, so if you reduce your IRA balance, you effectively reduce your RMDs.

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